Compliance Corner: Second Quarter 2004

A Reminder: April 2003 Amendments to Regulation B Are Now Mandatory

by Carletta M. Longo, Senior Examiner

As part of its policy to periodically review and update its
regulations, the Federal Reserve Board (Board) published a final rule amending
Regulation B, which implements the Equal Credit Opportunity Act (ECOA).
The final rule, which took effect on April 15, 2003, became mandatory on April
15, 2004. This article discusses the more substantive revisions to the
regulation. 1

Overall Purpose of ECOA When enacted in 1974, ECOA
prohibited discrimination on the basis of marital status and sex. Later, in
1976, the Act was amended to designate other prohibited bases of
discrimination, including race and national origin. Since then, ECOA has been
amended to:

Require creditors to provide business applicants notice of
the right to a written statement of reasons for a credit denial.

Impose record retention requirements for certain business
credit applications.

Require creditors to provide applicants with the right to
obtain a copy of any appraisal report used in connection with an application
for credit to be secured by residential real property.

Establish referral responsibilities on the part of the
federal financial supervisory agencies for referrals to the U.S. Departments of
Justice and Housing and Urban Development for certain violations of ECOA.

Create a privilege against disclosure of information
developed by creditors as a result of "self-tests" they conduct.

Currently, ECOA makes it unlawful for a creditor to discriminate
against an applicant in any aspect of a credit transaction on the basis of the
applicant's national origin, marital status, religion, sex, color, race, age
(provided the applicant has the capacity to contract), receipt of public
assistance benefits, or the good faith exercise of a right under the
Consumer Credit Protection Act (15 U.S.C. 1601 et seq.). In addition to
a general prohibition against discrimination, the regulation contains specific
rules concerning taking and evaluating credit applications, how credit history
information is reported on accounts used by spouses, procedures and notices for
credit denials and other adverse actions, and limitations on requiring
signatures of persons other than the applicant on credit documents. The
regulation also exempts certain types of credit, such as utilities credit and
securities credit, from some requirements, and provides model forms for
optional use by creditors.

Summary of Revisions to Regulation BThe April 2003
revisions to the regulation accomplished several purposes. In particular, the
revisions:

Clarified various definitions, including the definition of
"adverse action," "application," and "creditor."

Grouped the regulation's general rules into one section.

Created an exception to the general prohibition against
inquiring about or noting applicant characteristics for non-mortgage credit
transactions for the purpose of conducting a self-test.

Established rules for evaluating married and unmarried credit
applicants.

Required record retention for prescreened credit
solicitations.

Established rules for obtaining signatures of nonapplicants.

Clarified the requirements for providing a statement of
specific reasons in adverse action notifications.

Revised monitoring information provisions to comply with the
U.S. Office of Management and Budget's technical revisions to ethnicity.

Established requirements for electronic communication.

Clarified Definitions Adverse Action. Prior to the
final rule, the definition of "adverse action" included a creditor's
termination of or unfavorable change to the terms of an account, unless the
action affected "all or a substantial portion of a class of the creditor's
accounts." The words "substantial portion" were changed to "substantially all"
to clarify that a creditor's action must affect the overwhelming majority of
accounts in a designated class to be excluded from the definition of adverse
action.

The revision emphasizes that the exception applies only when the
creditor's action is not based on the individual credit characteristics of the
affected accountholders. For example, the exception would apply where a
creditor terminates all secured credit accounts because it no longer offers
that type of credit. However, the exception would not apply if the creditor
terminated only those secured credit accounts that could not be moved into
another card program after an evaluation of the individual credit
characteristics of the accountholders.

Application. The definition of "application" has been
expanded to include a request for a preapproved loan under procedures in which
a creditor issues creditworthy persons a written commitment to extend credit up
to a designated amount that is valid for a designated period of time, and
possibly subject to other conditions. The expanded definition is contained in
the Official Staff Commentary (Commentary) to the regulation, rather than the
regulation itself. The Commentary clarifies that certain preapprovals are
covered by the definition of application and further clarifies the difference
between a preapproval and a prequalification. 2

Creditor. To clarify the definition of "creditor," the
regulation's old language "regularly participates in the decision of whether or
not to extend credit" was changed to "regularly participates in a credit
decision, including setting the terms of the credit." Thus, creditor now
includes not only those that make the decision to deny or extend credit, but
also those that negotiate and set the terms of the credit with the consumer.
However, the regulation does hold that a potential assignee who establishes
underwriting guidelines for its purchases but does not influence individual
credit decisions is not a creditor.

Grouping of General RulesSection 202.4 has been
revised to group the regulation's general rules, some of which were previously
in other sections, into one section.

Section 202.4(c) (formerly §202.5(e)) contains the
requirement for written applications in mortgage transactions covered by
§202.13(a).

Section 202.4(d), which is new, generally requires written
notices and other disclosures to be provided in a clear and conspicuous manner
and in a form an applicant may retain. 3

Self-Testing ExceptionThe final rule retains the
general prohibition against a creditor inquiring about or noting an applicant's
sex, race, color, religion, or national origin for non-mortgage credit
products, subject to certain exceptions, including a new exception discussed
below. The Board continues to believe that the general prohibition helps to
reduce or avoid credit discrimination. At the same time, the Board also
believes that including a new exception that permits the collection of such
data for the purpose of conducting a self-test would provide creditors with an
additional tool to measure and improve compliance with ECOA. As such, the Board
created an exception to the general regulatory prohibition to permit creditors
to inquire about and note information about non-mortgage credit applicants'
personal characteristics for the purpose of conducting self-tests.

Accordingly, §202.5(b)(1) permits creditors to inquire
about and note personal characteristics such as race or national origin for the
purpose of conducting a self-test to determine the creditor's compliance with
ECOA or Regulation B. To qualify for this exception, the creditor must satisfy
all the elements of a self-test as set forth in the regulation, and must
provide credit applicants with the regulation's requisite disclosures at time
the information is requested.4 This exception to
the general prohibition applies to a self-test even if the creditor should
subsequently lose or waive the self-test privilege by disclosing any privileged
information as provided in §§202.15(d)(2)(i) and (ii). Other laws or
regulations, such as the Gramm-Leach-Bliley Act privacy regulations,
might restrict other disclosure of such data.

Section 202.15 of Regulation B implements the provisions that
govern the self-testing exception. The regulation defines a self-test as a
program, practice, or study designed and used specifically to determine
compliance with the Act and regulation, and that creates data or factual
information that is not available and cannot be derived from loan or
application files or other records related to credit transactions. The results
of the self-test cannot be obtained by a government agency in an examination or
investigation, or by an agency or an applicant in any proceeding or lawsuit
alleging a violation of ECOA or Regulation B. The privilege applies only if the
creditor takes appropriate corrective action when it determines that it is more
likely than not that a violation has occurred.

Evaluating Married and Unmarried Credit ApplicantsSections 202.6(b)(8) and (9) make clear that a creditor may not evaluate
married and unmarried applicants by different standards. The final rule
provides that the requirement applies except as otherwise permitted or required
by law. Thus, a creditor may consider the rules in §§202.5, 202.6,
and 202.7 in evaluating applications. But, a creditor that aggregates the
incomes of married co-applicants, for example, is required to aggregate the
incomes of unmarried co-applicants under this rule.

Prescreened Solicitations Record Retention The final
rule has expanded the record retention requirements of Regulation B to require
retention of information used in prescreened credit solicitations. Section
202.12(b)(7) was added to the regulation so that enforcement agencies can
review and analyze creditors' possible use of prohibited bases in connection
with such solicitations.

As already noted, ECOA prohibits discrimination by a creditor
against an applicanta person who has requested or received crediton
a prohibited basis regarding any aspect of a credit transaction. "Credit
transaction," as defined in Regulation B, covers every aspect of an applicant's
dealings with a creditor, beginning with requests for information. Thus, ECOA's
coverage encompasses a person who has, at a minimum, sought credit. But because
a person could be discouraged from seeking credit or credit information, the
regulation expressly prohibits a creditor from engaging in any practice
(including advertising) that would discourage on a prohibited basis a
reasonable person from applying for credit.

In some circumstances, consumers do not have to initiate a
request for credit, but rather respond to a solicitation from the creditor.
Creditors use a number of techniques to identify potential customers. For
example, creditors often specify criteria to consumer reporting agencies, which
then draw on information from credit files to compile lists of persons who meet
those criteria. This marketing techniqueinvolving prescreened
solicitationsis typically carried out through both mailed solicitations
and telemarketing. In marketing credit products through prescreened
solicitations, creditors frequently offer discounted introductory rates,
attractive credit terms, and enhancements (such as purchase discounts, in the
case of credit cards) that may not be available through other application
channels.

Although prescreened solicitations, particularly for credit
cards, are not new, the use of prescreened solicitations has become more
commonplace and more sophisticated with advances in technology that enable the
building of elaborate databases. Prescreened solicitations can be used to
target consumers most likely to use a particular credit product, or to target
segments of the population that are most likely to respond to a certain
product. Conversely, prescreened solicitations can be used to exclude certain
consumers from receiving offers of credit. They can also be used to target
consumers in low-income neighborhoods (which are often predominantly minority)
for less favorable credit products or credit terms on the supposition that such
consumers are less creditworthy. Occasionally, some creditors, primarily credit
card issuers, have used age to identify potential recipients of preapproved
credit.

The expanded retention provisions of the regulation require
creditors to retain records related to the text of the solicitations, the
criteria used to select potential customers for prescreened solicitations, and
correspondence related to consumer complaints. The Board believes that the
expanded provisions will provide useful information without imposing excessive
burden. Nothing in the final rule requires creditors to establish a separate
database or set of files for correspondence relating to complaints about
prescreened solicitations, and creditors will not be required to match consumer
complaints with specific solicitation programs. Creditors will have the
flexibility to retain correspondence in any manner that would make it
reasonably accessible and understandable to examiners.

Signatures of NonapplicantsSection 202.7(d)(1) has
been revised and provides that a creditor may not require the signature of a
person other than an individual applicant on any credit instrument if the
applicant is individually creditworthy. Over the years, the Board has received
questions about how creditors can establish that applicants intend to apply
jointly. Although the issue arises in consumer credit, it is more prevalent in
the context of business or commercial credit.

The final rule prohibits a creditor from presuming that the
submission of joint financial information (for example, a joint personal
financial statement) constitutes an application for joint credit. The fact that
a credit applicant owns property with another and submits information
concerning the property and the joint owner in order to establish
creditworthiness does not mean that both owners intend to be obligated for the
extension of credit. Evidence of intent to apply for joint credit requires more
than the submission of joint financial information and must expressly reflect
the intent of both owners.

Additional guidance concerning how to evidence intent to apply
for joint credit is provided in the Commentary to §202.7(d)(1) in comment
7(d)(1)-3. Also, Appendix B to Regulation B includes various model application
forms that contain an optional clause that an applicant may choose to evidence
an applicant's affirmative attestation to be a joint applicant. 5

Adverse Action NotificationsThe legislative history
of the requirement to provide specific reasons for adverse action indicates
that the purposes of the disclosure are to help achieve the anti-discrimination
goals of ECOA and to educate and inform consumers. In this regard,
§202.9(b)(2) of Regulation B has been revised to address the dual purposes
of the statement of specific reasons.

In particular, §202.9(b)(2) clarifies that, whether a
creditor's denial of credit is based on the creditworthiness of the applicant,
a joint applicant, or guarantor, the reasons for adverse action must be
specific. For example, a general statement that, "the guarantor did not meet
the creditor's standards of creditworthiness," is not sufficient. Instead, the
reason or reasons provided should be specific enough to inform the denied
applicant(s) of why the guarantor did not meet the standards of
creditworthiness (e.g., the guarantor's history of delinquent credit
obligations).

This clarification will likely discourage a creditor from
discriminating based on a co-applicant or guarantor's race, sex, age, or other
prohibited basis. Also, the disclosure may help educate and inform applicants,
co-applicants, or guarantors as to reasons for denial that are not apparent
from a review of their credit reports.

The Board did consider concerns raised regarding a co-applicant
or guarantor's privacy when the reasons for adverse action pertaining to
creditworthiness are given to the primary applicant. However, the Board
reasoned that when a person agrees to be a co-applicant, guarantor, or similar
party, there is (or should be) a general understanding that such information
will be shared.

Revised Monitoring ProvisionsTechnical revisions
have been made to §202.13 of the regulation to conform to a 1997 U.S.
Office of Management and Budget (OMB) directive related to ethnicity and race.
For ethnicity, the standards provide for requesting data on whether or not
individuals are Hispanic or Latino. The standards also prescribe five racial
designationsAmerican Indian or Alaska Native, Asian, Black or African
American, Native Hawaiian or Other Pacific Islander, and White. The standards
eliminate the option of designating "Other," which Regulation B previously
allowed.

The standards also require that respondents be offered the
option of selecting more than one racial designation. The regulation's Appendix
B now contains a model application form that bankers may use to comply with
§202.13 that includes the OMB's race and ethnicity designations.

Electronic Communication The passage of the
Electronic Signatures in Global and National Commerce Act (otherwise
known as the E-Sign Act), signed into law by President Clinton on June
30, 2000, allows a creditor to provide disclosures in an electronic format
provided that certain specifications are met. Section 202.16 of Regulation B
now incorporates the requirements of the E-Sign Act.6

Conclusion To ensure ongoing compliance with
Regulation B, financial institution management should be aware of the
regulation's changes and their potential impact on the institution and its
operations. The institution's policies and procedures should be modified and
enhanced as necessary to address the changes, and employee training should be
conducted as appropriate. Compliance oversight, including compliance audits and
reviews, should be intensified during the initial stages of procedures
modification and enhancement to ensure that ongoing procedures are effective.

If you have any questions regarding the changes to Regulation B,
please contact Senior Examiner Carletta M. Longo or
Robin P. Myers, Consumer Compliance/CRA Examinations Unit Manager
through the Regulations Assistance Line at (215) 574-6568.

1 The final rule and full text of
Regulation B are available on the Board of Governors' website.
The Official Staff Commentary and Official Staff Interpretations to Regulation
B also provide additional information and clarification to the amendments,
along with specific examples and explanations.

3 The final rule exempts disclosures
under §202.5, Rules Concerning Requests for Information, and §202.13,
Information for Monitoring Purposes, even if provided in writing, from the
retention requirement.

4 A model notice is included in
Appendix C to Regulation B to facilitate compliance with the disclosure
requirements.